Mutual funds are an efficient investment instrument that pools capital from various investors to curate a diversified portfolio managed by professional financial managers. By trading on exchanges, they facilitate individuals’ access to different trading instruments (stocks, bonds, and short-term debt). Investors hold stakes in these funds, which means they own shares and share in the generated returns.
To ace the concepts of Mutual Funds, we will discuss the following topics in detail:
What are Mutual Funds?
A mutual fund is a type of trust that raises funds from investors with similar financial goals and invests those funds according to the investment objective in a variety of asset classes. In simple terms, mutual funds are financial intermediaries created to manage the money acquired from various investors skillfully.
It is established as a trust, with a Sponsor, Trustees, Asset Management Company (AMC), and Custodian. The trust is created by one or more sponsors who are registered with the Securities and Exchange Board of India (SEBI) and act similarly to a company’s promoter.
Small or individual investors have access to professionally managed portfolios of stocks, bonds, and other securities through mutual funds. As a result, each shareholder shares proportionately in the fund’s profits or losses.
Additionally, Net asset value per share (NAV) is another name for the unit price of mutual funds in India. The NAV is determined by dividing the total amount of Indian mutual funds by the daily number of issued and outstanding units.
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Why should we buy mutual funds?
In the field of Investment Banking, the reason for buying mutual funds is quite simple as it makes investment easy, convenient, and reasonable by collecting money from many investors to purchase securities.
Professional management, diversity, liquidity, affordability, simplicity, and ease of recordkeeping are just a few benefits of mutual funds. Customers who have taken mutual funds also benefit from complete disclosure and strict government regulation.
Experienced traders understand that diversifying their portfolios can lessen the adverse effects of a single investment. You can have a diversified portfolio through a mutual fund at a far lower cost than you could likely manage on your own. There are many investment-related books where you can also learn about the experiences of other famous traders.
Mutual funds can beat inflation over the long term, create capital, and deliver attractive returns on investments. It has greater exposure to the investment fund and a balanced risk-return ratio due to its investments in a variety of assets, sectors, and businesses.
Mutual funds have recently gained enormous popularity, and the industry is growing exponentially. One of the reasons is that it provides different kinds of plans to meet the needs of the investors.
How Does a Mutual Fund Work?
A mutual fund collects money from several investors to create a diversified portfolio of securities as outlined in the Scheme Offer Documents.
Let’s Explain How a Mutual Fund Functions
Investors contribute funds to the mutual fund scheme by purchasing units, each representing a share of ownership in the fund’s assets. The fund aims to follow a specific investment strategy, which dictates the types of securities it will buy and exposes it to market risks.
Typically, mutual fund schemes invest across a wide variety of securities to reduce risk. The fund manager actively oversees the portfolio, making buy, hold, or sell decisions on the underlying securities based on their research and analysis. In contrast, passive mutual funds aim to replicate the performance of a particular market index to enhance returns. The portfolio of a passive fund mirrors a selected market index, like Nifty or Sensex, maintaining a composition and investment proportion that aligns with the tracked index while acknowledging the potential for tracking error.
How to Invest in Mutual Funds
- Investing in mutual funds is fairly simple and involves these key steps:
- Before purchasing shares, check with your employer to see if they provide any additional mutual fund offerings, as these may include matching funds or offer better tax advantages.
- Make sure you have a brokerage account that is sufficiently funded and allows you to buy mutual fund shares.
- Look for mutual funds that align with your investment objectives regarding risk, returns, fees, and minimum investment requirements. Many platforms provide screening and research tools for this purpose.
- Decide on the amount you wish to invest and submit your order. You may also have the option to establish automatic recurring investments if you prefer.
- Although these investments are typically for the long term, it’s a good idea to periodically review the fund’s performance and make adjustments as necessary.
When you’re ready to exit your position, simply place a sell order through your platform.
How are earnings determined for mutual funds?
Investors generally earn returns from a mutual fund in three modes:
- Dividend/interest income: Mutual funds distribute stock dividends and bond interest from their portfolios. Investors can choose to receive distributions via check or reinvest them for more shares.
- Portfolio distributions: When the fund sells appreciated securities, it realizes a capital gain, typically passed on to investors.
- Capital gains distribution: If the fund’s shares appreciate, you can sell them for a profit market.
How do mutual funds work in India with an example?
Let’s understand how a mutual fund works using an example. First, it’s essential to know the meaning of Net Asset Value (NAV), which is the price at which investors buy or redeem their mutual fund investments. Investment units are based on NAV.
For instance, if you invest Rs. 400 in a mutual fund with an NAV of Rs. 10, you receive 40 units (400/10). If the value of the fund’s assets changes, the NAV also changes.
If NAV increases to Rs. 30, those 40 units become worth Rs. 1,200 (40 units * Rs. 30). When you redeem your investment, you will get Rs. 1,200 instead of the Rs. 400 invested initially. These returns are called capital gains.
Advantages and Disadvantages of Mutual Funds
Advantages of Mutual Funds
In the previous section, we got to know about the various types of financial markets funds. Let us see the various advantages offered by mutual funds:
Under Section 80C of the Income Tax Act, 1961, you are able to invest in tax-saving mutual funds known as ELSS (Equity Linked Savings Scheme) that are eligible for a tax deduction of up to Rs 1.5 lakh each year.
Mutual funds may contain hundreds or thousands of securities investing from various businesses, industries, and geographic areas. By diversifying their holdings, investors can lower the risk associated with a specific stock or industry.
The key takeaway is that by participating in a mutual fund, small-dollar individual investors gain access to a diverse pool of securities, something they could not otherwise do.
To build a diverse portfolio, a single investor can purchase stocks or bonds through a mutual fund for a lot less money than they could do it directly.
Undertakings for the Collective Investment in Transferable Securities (UCITS) follow a strict regulatory framework under which they are structured, managed, and invested. As a result, this provides a safety net for the end investors.
Disadvantages of Mutual Funds
Let’s look at the drawbacks of mutual funds so you can learn about the safety measures you should take when investing:
A mutual fund unit price changes due to the movements of the underlying securities. This is the reason why mutual funds cannot ensure a specific rate of return or return on investment.
It would be wiser to invest in more conventional banking products if an investor is risk-averse and demands complete assurance.
Diversification is frequently listed as one of a mutual fund’s key drawbacks. There is, however, always a chance of over-diversity, which might raise a fund’s running costs, need more due diligence, and erode the relative benefits of diversification.
Mutual funds do not promise set returns, so you should always be ready for anything, even a decline in the value of your mutual fund. In other words, there are many different price variations associated with mutual funds.
Even though long-term investors rarely experience losses, if you unintentionally invest before a terrible period, you will suffer a capital loss. Returns from mutual funds are never assured. Hence, before investing, it is advisable to have some basic knowledge of the economy and fund performance.
Types of Mutual Funds
The four main types of mutual funds are equities funds, fixed-income funds, money market funds, and hybrid funds. These mutual fund examples are based on the asset classes that the funds invest in:
Equity funds invest largely in the stocks of various companies. These funds usually have high levels of investment risk because they invest in the equity markets. You can also include equity investment in your portfolio through this.
Fixed-income funds are also referred to as bound funds. Bonds issued by firms and the government make up the majority of the investments made by fixed-income funds. These mutual funds aim to give investors a reliable source of income as opposed to equities funds, which rely on capital appreciation from rising share prices.
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This is the type of fund that resembles fixed-income funds but usually limits their assets to government-issued, highly-rated short-term securities such as certificates of deposit, T-bills, short-term bonds, and dated securities.
A hybrid is the type of fund that invests pooled money into both stocks and debt securities. The ratio of investment in both stocks and debt securities depends on the fund manager and can either be fixed or variable in nature.
A debt fund is a kind of mutual fund that primarily invests in fixed-income assets including government securities, bonds, and many other debt instruments. This fund’s main objective is to preserve capital while providing monthly interest payments to investors as a source of income.
Top Mutual Funds in India
Motilal Oswal Flexicap Fund Direct Plan Growth
- Category Rank: 1
- NAV: ₹72.04
- Fund Size: ₹12,023.89 Cr
- Fund Return: 54.23%
- Category Return: 29.17%
- Risk Level: Very High
Invesco India Flexi Cap Fund Direct Growth
- Category Rank: 2
- NAV: ₹20.30
- Fund Size: ₹2,259.68 Cr
- Fund Return: 43.77%
- Category Return: 29.17%
- Risk Level: Very High
JM Flexicap Fund (Direct) Growth Option
- Category Rank: 3
- NAV: ₹120.63
- Fund Size: ₹4,721.61 Cr
- Fund Return: 42.88%
- Category Return: 29.17%
- Risk Level: Very High
Bank of India Flexi Cap Fund Direct Growth
- Category Rank: 4
- NAV: ₹40.08
- Fund Size: ₹1,929.59 Cr
- Fund Return: 40.58%
- Category Return: 29.17%
- Risk Level: Very High
360 ONE Flexicap Fund Direct Growth
- Category Rank: 5
- NAV: ₹15.97
- Fund Size: ₹1,147.52 Cr
- Fund Return: 38.79%
- Category Return: 29.17%
- Risk Level: Very High
HSBC Flexi Cap Fund Growth Direct
- Category Rank: 6
- NAV: ₹252.63
- Fund Size: ₹5,164.96 Cr
- Fund Return: 38.69%
- Category Return: 29.17%
- Risk Level: Very High
Edelweiss Flexi Cap Fund Direct Growth
- Category Rank: 7
- NAV: ₹45.20
- Fund Size: ₹2,364.93 Cr
- Fund Return: 38.02%
- Category Return: 29.17%
- Risk Level: Very High
ITI Flexi Cap Fund Direct Growth
- Category Rank: 8
- NAV: ₹19.17
- Fund Size: ₹1,262.58 Cr
- Fund Return: 36.97%
- Category Return: 29.17%
- Risk Level: Very High
Bajaj Finserv Flexi Cap Fund Direct Growth
- Category Rank: 9
- NAV: ₹14.77
- Fund Size: ₹3,883.01 Cr
- Fund Return: 34.93%
- Category Return: 29.17%
- Risk Level: Very High
WhiteOak Capital Flexi Cap Fund Direct Growth
- Risk Level: Very High
- Category Rank: 10
- NAV: ₹18.14
- Fund Size: ₹4,149.17 Cr
- Fund Return: 33.09%
- Category Return: 29.17%
Conclusion
One of the highest rates of global saving is found in India. Indian investors must look beyond the gold and bank FDs that have historically been their best-preferred investment method. Therefore, it is always advisable to invest in mutual funds rather than using old practices, as mutual funds offer multiple product choices for investment across the financial spectrum. For those looking to deepen their understanding of such opportunities, enrolling in investment banking courses online can provide valuable insights into market trends and smarter investment strategies.